Sunday, February 02, 2020
No rate cut, but no chance of a hike either
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

My regular column is available to subscribers on This is an excerpt.

In the end, like a lot of sporting events in which there is a lot of excitement in the build-up, it was not that much of a contest. On Thursday lunchtime, as you will know, the Bank of England’s monetary policy committee (MPC) left interest rates unchanged at 0.75% by the same 7-2 majority as in November and December.

What was billed in the City as the most unpredictable decision on rates for years passed without incident. Those who were confident of a cut in rates will live to fight another day, I hope, and are busy blaming the Bank’s mixed signals. Those who thought the markets had got ahead of themselves in predicting a cut, particularly earlier last month when the probability rose to more than 70%, will have enjoyed their moment of preening.

I never preen but, as I argued here, there was no need to cut now and it would have been premature to do so, although the question of whether lower rates will be needed later in the year remains a live one. The Bank is assuming that a “deep” free trade agreement between Britain and the EU can be finalised before the end of the year, because that is government policy. There is no guarantee of that.

The Bank’s new growth forecasts, just 0.8% this year, rising to 1.4% next, are strikingly weak. If this is the “Boris bounce”, the government needs a new trampoline. When growth overall is just 0.8%, some sectors and regions of the economy will be in recession. For others it will feel like it. Nobody on the MPC can be blamed for voting for lower interest rates in these circumstances.

Despite the fact that there was no change, the excitement leading up to Thursday’s decision made more than a little nostalgic for the days when interest rate changes were big, bold and unpredictable. I remember a month which started with official interest rates at 9.5% and ended at 14%.

Most people in business, I would guess, are glad that those days are over, and interest rates boringly low. But, and we should be realistic about this, there is also plainly a limit on what interest rates can do. Deciding whether or not to cut when interest rates are only 0.75% is not quite a case of bald men arguing over a comb but it can never be transformative. Sterling edged up a little after the non-cut, but there was not much else.

This is not to say that monetary policy can do nothing. The package of measures the Bank announced in August 2016, in the wake of the EU referendum, undoubtedly helped support the economy. Although people remember most that there was a cut in official interest rates then, from 0.5% to just 0.25%, that was the least important part of the Bank’s stabilising package, which included a further £65 billion of quantitative easing and a term funding scheme for the banks to ensure that they continued lending into the economy.

In normal circumstances, however, interest rates moves at this level are more about signalling by central banks than their actual impact. Last year saw mortgage rates on new loans fall by between 0.25 and 0.5 percentage points, depending on the type of loan.

This fall was market-driven, and mostly occurred during a period when the Bank’s declared position was that it was aiming for “limited and gradual” rate rises. There were no votes for cuts in rates until November. Lower mortgage rates reflected the drop in long-term interest rates; falling gilt yields (the market interest rate on UK government bonds).

Mortgage rates used to fall only when official interest rates were reduced and, indeed, made any such reduction a big deal for households. Not any longer.
Thursday was the last interest rate announcement to be presided over by Mark Carney, who channelled Edith Piaf when he said that he had no regrets about the conduct of monetary policy on his watch.

When he arrived at the Bank in 2013 Bank rate was 0.5%. He leaves with it at 0.75%. I asked him whether he would have been surprised had been told then that the process of bringing interest rates back to normal levels would have been so slow.

His answer was “yes” and it is not hard to work out why. Three interest rate changes in seven years – one cut and two hikes – tell their own story about an economy beset with uncertainty.

The outgoing governor had another essential point, however, and this was that the equilibrium rate of interest, known to economists as R*, had proved to be lower than expected. The extent to which rate increases were possible without going too far, in other words, had come down.

This has been true for all advanced economies since the global financial crisis but, as he suggested, perhaps even more pronounced for the UK than elsewhere. The government’s deficit reduction programme, austerity, bore down significantly on interest rates to a greater extent than in other countries, and Brexit uncertainty has been a significant economic drag.

Does that mean, with the government having already announced a big boost to public spending from April, with more to come alongside a modest tax cut in the March 11 budget, that there will be more scope for higher interest rates in future? On this argument, the equilibrium interest rate should be higher when the government is providing a fiscal boost and there is greater certainty about some aspects of Brexit.

Sadly, however, for those who are yearning for higher interest rates, pretty well everything else in the Bank’s assessment screams that they will be going nowhere fast. There was a time, and not that long ago, when the “supply potential” of Britain’s economy was thought to be around 2.5% a year. The Treasury even toyed with a 3% figure in the 2000s.

But not any more. The years of productivity stagnation have taken their toll and are now embedded in the Bank’s projections. There is limited scope for Britain to do much more of what it has been doing in the absence of productivity growth, which is to add workers. The employment rate cannot rise much further from here.

The result is a potential growth rate of just 1.1% a year, according to the Bank, which is feeble in the extreme, and which looks almost too downbeat to be true. When the economy’s ability to grow is so low, it does not take much of a flurry in economic activity to add to inflationary pressures, and make the case for higher interest rates.

But not, I think, for a very long time. An interest rate cut now would have been like that now ancient Beyond the Fringe sketch with Peter Cook and Jonathan Miller – “what we need now is a futile gesture” – but by the same token, years may pass before this economy will be ready for higher interest rates,